Litigation + Valuation Perspectives

Demystifying Valuation, Economic Damages + Forensic Accounting

Buy-Sell Agreement: Part I

Buy-Sell agreements can be an important part of your business, and should be well thought out. They can have legal, tax and valuation ramifications, so you should consult experts in each of these fields when drafting or modifying a Buy-Sell agreement.

Buy-Sell agreements can be used for several purposes. The agreement can provide a market for a business owner’s interest. It can prevent departed owners from sharing in future benefits, and potentially avoid future conflicts with departed owners. The Buy-Sell can also protect the company’s elected tax status and provide a barrier against being saddled with unwelcome owners.

There are generally three types of Buy-Sell agreements:

  • A redemption agreement allows the business entity to finance the redemption of the ownership interest.
  • A cross purchase agreement relies on the remaining owner(s) to buy the ownership interest.
  • A hybrid agreement generally gives either the entity or remaining owner(s) a right of first refusal and often contains a secondary right of first refusal.

Each of the three types of agreements can be partially or fully funded with insurance. The use of insurance doesn’t solve all issues, for example: Are all the owners insurable? If you intend to fund with insurance, will the proceeds be available for triggering events other than the death of the owner? And how much insurance is enough? That may depend on the value and timing of the payments under the agreement. The Value of a Buy-Sell Agreement will be covered next week.